The riskiness of home ownership

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rbaldini
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The riskiness of home ownership

Post by rbaldini » Tue Oct 18, 2016 5:09 pm

Y'all,

I'll likely be buying a house some time in the next year, in the Boulder, CO area. I've been thinking more about the financial aspects of home ownership. It recently struck me that buying a house on a loan is relatively risky decision, in the sense that the range of outcomes is greater than renting + investing that money in the market - i.e. you can make a lot, but you can also lose a lot. I think there are two main reasons for this:
(1) Since you can buy a house with only 20% down, you can leverage to potentially realize very large returns or losses. For example, with only $100,000 you can buy a $500,000 house, and therefore realize the returns or losses of whatever happens to that house (minus interest on loan, commission to realtor, etc.).
(2) The lack of a capital gains tax on your residential property (well, on the first $500k for a married couple) swings both ways: you don't pay taxes if you win, but you can't write it off if you lose... right?

To investigate this, I made a stochastic simulation of the costs of renting vs. buying. I modeled it off of the NYTimes website (http://www.nytimes.com/interactive/2014 ... lator.html), except that rather than having the user input the market and house returns, I simulated 1000's of possible future time series based on some historical data for both stock returns and Boulder house prices. Long story short, it is indeed the case that the range of costs is usually greater for home ownership than for renting: you can make a lot or lose a lot. On average, buying is the better decision for the price range of houses I'm looking at, but the potential downside is a bit daunting. Reinforces my inclination to buy something cheap.

I don't have any particular questions here - just wondering if y'all have any input, or think that I'm going about this the wrong way. Would be happy to talk about the model a bit more.

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mhc
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Re: The riskiness of home ownership

Post by mhc » Tue Oct 18, 2016 5:16 pm

You also have the risk that comes from having a concentrated position. A lot of homeowners have a large percentage of their wealth tied up in their houses. Not very diversified.

mouses
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Re: The riskiness of home ownership

Post by mouses » Tue Oct 18, 2016 5:17 pm

I've never bought a house as an investment, rather as a home.

aceoperations
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Re: The riskiness of home ownership

Post by aceoperations » Tue Oct 18, 2016 5:25 pm

This sounds interesting. Can you post any charts/data that your simulations produced? Is there any way to share your methodology so that others can use it in their particular situation? I'd imagine it would benefit many here.

rbaldini
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Re: The riskiness of home ownership

Post by rbaldini » Tue Oct 18, 2016 5:32 pm

mhc wrote:You also have the risk that comes from having a concentrated position. A lot of homeowners have a large percentage of their wealth tied up in their houses. Not very diversified.
Right. It's strange to me that this is rarely discussed. There's a common rule of thumb for mortgage-to-income ratio, which goes something like "don't take on a mortgage bigger than 3x your income", etc. But I've never seen any rule of thumb regarding house-value-to-net-worth ratio - e.g., don't have your home be more than 50% of your net worth, or something. Possibly because such a rule would strongly discourage home ownership except among those with large net worth.

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happyisland
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Re: The riskiness of home ownership

Post by happyisland » Tue Oct 18, 2016 5:46 pm

mouses wrote:I've never bought a house as an investment, rather as a home.
Agreed. From my understanding, it is generally a bad idea to expect a house to appreciate like an actual investment.

rbaldini
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Re: The riskiness of home ownership

Post by rbaldini » Tue Oct 18, 2016 5:48 pm

aceoperations wrote:This sounds interesting. Can you post any charts/data that your simulations produced? Is there any way to share your methodology so that others can use it in their particular situation? I'd imagine it would benefit many here.
Probably won't have time to do this for a day or two. I'll give a bit more detail now.

Given a time series of stock returns and house price changes, one can calculate the cost of either option - i.e. renting and using your greater liquidity to invest in the market, vs. buying a house. Basically the cost of renting is just the rent itself (ideally accounting for rent increase through time). For a house, it's more complicated: first you pay closing costs and down payment, then you pay PITI and maintenance costs for n years, then you sell your house (with some proportion lost to commission, usually), then you pay off the rest of your mortgage loan. You also want to account for the opportunity cost: all that money you put down in closing costs and down payment can't be invested in the market, which would have likely gotten some positive return minus capital gains tax (though of course the market could also lose you money). (I've never actually bought or sold a house, so please correct me if I've got this wrong!!)

The NY Times site does all this. The problem is that it requires you to input a guess for the market returns and house price growth over that time (the default options for both are a bit conservative, IMO). This only allows you do it one at a time, so you don't easily get a sense of the range of outcomes that could happen - e.g., what if we have really bad real estate years but decent stock years? Or the opposite?

So this is where a stochastic model comes in handy. I used S&P 500 annual returns (here: http://pages.stern.nyu.edu/~adamodar/Ne ... retSP.html) and house price history in Boulder CO (here: http://www.zillow.com/research/data/) to fit a correlated random walk model of the two processes (basically a bivariate normal model). Then used that to simulate 1000s of possible future outcomes, which quickly allows me to see the range of possible outcomes in a split second. An important thing to realize is that the historical house price values only go back to 1997 - a very small sample size. I use a Bayesian approach that makes use of that uncertainty to basically create larger confidence intervals: basically, it recognizes that the small sample means that there is a lot of uncertainty about what the future actually holds. (Another methodological issue is that Zillow smoothed the house price data with a 5-year moving average, which greatly reduces the house price volatility estimate. Assuming that price changes over years aren't auto-correlated, I corrected this by multiplying the variance by 5).

Again, buying a house is *usually* better, but the range of outcomes is greater. Greater risk, greater reward.

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Re: The riskiness of home ownership

Post by BogleBoogie » Tue Oct 18, 2016 5:55 pm

rbaldini wrote:Y'all,

I'll likely be buying a house some time in the next year, in the Boulder, CO area. I've been thinking more about the financial aspects of home ownership. It recently struck me that buying a house on a loan is relatively risky decision, in the sense that the range of outcomes is greater than renting + investing that money in the market - i.e. you can make a lot, but you can also lose a lot. I think there are two main reasons for this:
(1) Since you can buy a house with only 20% down, you can leverage to potentially realize very large returns or losses. For example, with only $100,000 you can buy a $500,000 house, and therefore realize the returns or losses of whatever happens to that house (minus interest on loan, commission to realtor, etc.).
(2) The lack of a capital gains tax on your residential property (well, on the first $500k for a married couple) swings both ways: you don't pay taxes if you win, but you can't write it off if you lose... right?

To investigate this, I made a stochastic simulation of the costs of renting vs. buying. I modeled it off of the NYTimes website (http://www.nytimes.com/interactive/2014 ... lator.html), except that rather than having the user input the market and house returns, I simulated 1000's of possible future time series based on some historical data for both stock returns and Boulder house prices. Long story short, it is indeed the case that the range of costs is usually greater for home ownership than for renting: you can make a lot or lose a lot. On average, buying is the better decision for the price range of houses I'm looking at, but the potential downside is a bit daunting. Reinforces my inclination to buy something cheap.

I don't have any particular questions here - just wondering if y'all have any input, or think that I'm going about this the wrong way. Would be happy to talk about the model a bit more.
I bought a house in 2004 for around $230k. I sold it for $430k a few years later. I guess it can be risky or profitable. I don't view mine as an investment. I live in in and enjoy it with an emotional attachment. If I sold my current house today I'd make 6 figures profit. Eventually I'll own it out right.

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Re: The riskiness of home ownership

Post by Dottie57 » Tue Oct 18, 2016 5:58 pm

mouses wrote:I've never bought a house as an investment, rather as a home.
+1

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Re: The riskiness of home ownership

Post by Dottie57 » Tue Oct 18, 2016 6:01 pm

rbaldini wrote:
mhc wrote:You also have the risk that comes from having a concentrated position. A lot of homeowners have a large percentage of their wealth tied up in their houses. Not very diversified.
Right. It's strange to me that this is rarely discussed. There's a common rule of thumb for mortgage-to-income ratio, which goes something like "don't take on a mortgage bigger than 3x your income", etc. But I've never seen any rule of thumb regarding house-value-to-net-worth ratio - e.g., don't have your home be more than 50% of your net worth, or something. Possibly because such a rule would strongly discourage home ownership except among those with large net worth.
Networth is assets -liabilities. When I bought my house my networth was definitely negative

rbaldini
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Re: The riskiness of home ownership

Post by rbaldini » Tue Oct 18, 2016 6:05 pm

happyisland wrote:
mouses wrote:I've never bought a house as an investment, rather as a home.
Agreed. From my understanding, it is generally a bad idea to expect a house to appreciate like an actual investment.
Perhaps "expect" is the wrong word, but historically the prices of houses do tend to rise. It seems reasonable to view it as a high-risk, high-reward investment, depending on how much you put down. All the usual caveats apply - don't put all eggs in one basket, past performance does not guarantee anything in the future, etc.

KlangFool
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Re: The riskiness of home ownership

Post by KlangFool » Tue Oct 18, 2016 6:08 pm

OP,

I have 2 rules that EVERYONE does not like.

1) The house's price has to be 1/2 to 1/3 of your net worth excluding the house.

2) The mortgage payment (PITI) has to be CHEAPER than renting. No game is allowed. You have to compare the HOUSE that you are buying versus RENTING. Most people play a game by comparing the HOUSE that they buy and ASSUME that they will RENT the same HOUSE. That is NOT TRUE. Most people RENT less house.

Now, if you follow those 2 rules, you DO NOT CARE whether you make money from THE HOUSE. You will buy LESS HOUSE. It is THE SAME or CHEAPER than RENTING. You count THE HOUSE as an ongoing expense.

KlangFool

rbaldini
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Re: The riskiness of home ownership

Post by rbaldini » Tue Oct 18, 2016 6:11 pm

Dottie57 wrote:
rbaldini wrote:
mhc wrote:You also have the risk that comes from having a concentrated position. A lot of homeowners have a large percentage of their wealth tied up in their houses. Not very diversified.
Right. It's strange to me that this is rarely discussed. There's a common rule of thumb for mortgage-to-income ratio, which goes something like "don't take on a mortgage bigger than 3x your income", etc. But I've never seen any rule of thumb regarding house-value-to-net-worth ratio - e.g., don't have your home be more than 50% of your net worth, or something. Possibly because such a rule would strongly discourage home ownership except among those with large net worth.
Networth is assets -liabilities. When I bought my house my networth was definitely negative
Right. Hence the difficulty of any net-worth-based rule of thumb. Most people wouldn't be able to afford houses if they followed a rule that said something like "don't buy any house greater than one's net worth." Still, it's strange that we think it's "okay" for someone to buy a house whose value dwarfs the buyer's net worth...

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Re: The riskiness of home ownership

Post by rbaldini » Tue Oct 18, 2016 6:16 pm

KlangFool wrote:OP,

I have 2 rules that EVERYONE does not like.

1) The house's price has to be 1/2 to 1/3 of your net worth excluding the house.

2) The mortgage payment (PITI) has to be CHEAPER than renting. No game is allowed. You have to compare the HOUSE that you are buying versus RENTING. Most people play a game by comparing the HOUSE that they buy and ASSUME that they will RENT the same HOUSE. That is NOT TRUE. Most people RENT less house.

Now, if you follow those 2 rules, you DO NOT CARE whether you make money from THE HOUSE. You will buy LESS HOUSE. It is THE SAME or CHEAPER than RENTING. You count THE HOUSE as an ongoing expense.

KlangFool
I can see why people don't like these rules! I couldn't buy any house worth more than $125k - difficulty to swing in my area.

Personally I think your rules are too conservative. One of course needs to make sure he can afford the monthly PITI obligation, and that's the main reason I'm staying well within my means. But rent money goes into a black hole, whereas any money paid in PITI partly goes to paying off a loan. Assuming common house price increase, you can usually afford more house than you can in rent, long-term, since you get money back when you sell the house. But it's certainly risky, as I've taken pains to emphasize in this thread. Anyway, to each his own.

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oldzey
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Re: The riskiness of home ownership

Post by oldzey » Tue Oct 18, 2016 6:17 pm

Home ownership is a risk I'm not willing to take (or can afford for that matter).

JL Collins has a couple good posts on this issue that are worth a read:

http://jlcollinsnh.com/2012/02/23/rent- ... e-numbers/
http://jlcollinsnh.com/2013/05/29/why-y ... nvestment/

Enjoy!
"The broker said the stock was 'poised to move.' Silly me, I thought he meant up." ― Randy Thurman

rbaldini
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Re: The riskiness of home ownership

Post by rbaldini » Tue Oct 18, 2016 6:23 pm

oldzey wrote:Home ownership is a risk I'm not willing to take (or can afford for that matter).

JL Collins has a couple good posts on this issue that are worth a read:

http://jlcollinsnh.com/2012/02/23/rent- ... e-numbers/
http://jlcollinsnh.com/2013/05/29/why-y ... nvestment/

Enjoy!
Based on my (amateur) analysis, this guy is probably pushing a bit too hard. In the price range I'm looking at, the expected return of buying (as opposed to renting) is still positive - i.e. probably a good idea. It's just that it's more risky, so one needs to be sure he can handle the cost if prices drop. Of course, he makes fine points in that houses are illiquid, require maintenance, are taxed simply by existing, require insurance, etc. (I baked those latter facts into the model.)

KlangFool
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Re: The riskiness of home ownership

Post by KlangFool » Tue Oct 18, 2016 6:36 pm

rbaldini wrote:
KlangFool wrote:OP,

I have 2 rules that EVERYONE does not like.

1) The house's price has to be 1/2 to 1/3 of your net worth excluding the house.

2) The mortgage payment (PITI) has to be CHEAPER than renting. No game is allowed. You have to compare the HOUSE that you are buying versus RENTING. Most people play a game by comparing the HOUSE that they buy and ASSUME that they will RENT the same HOUSE. That is NOT TRUE. Most people RENT less house.

Now, if you follow those 2 rules, you DO NOT CARE whether you make money from THE HOUSE. You will buy LESS HOUSE. It is THE SAME or CHEAPER than RENTING. You count THE HOUSE as an ongoing expense.

KlangFool
I can see why people don't like these rules! I couldn't buy any house worth more than $125k - difficulty to swing in my area.

Personally I think your rules are too conservative. One of course needs to make sure he can afford the monthly PITI obligation, and that's the main reason I'm staying well within my means. But rent money goes into a black hole, whereas any money paid in PITI partly goes to paying off a loan. Assuming common house price increase, you can usually afford more house than you can in rent, long-term, since you get money back when you sell the house. But it's certainly risky, as I've taken pains to emphasize in this thread. Anyway, to each his own.
rbaldini,

1) I bought a house with my rules.

2) Too many of my peers choose not to follow those rules and they did not survive financially.

<< But rent money goes into a black hole, whereas any money paid in PITI partly goes to paying off a loan. Assuming common house price increase, >>

This is how people buy TOO MUCH HOUSE and got themselves KILLED by THE HOUSE. The house price around here is not back to the 2004/2005 level. And, this is one of the hottest areas.

KlangFool

joebh
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Re: The riskiness of home ownership

Post by joebh » Tue Oct 18, 2016 6:39 pm

rbaldini wrote:Long story short, it is indeed the case that the range of costs is usually greater for home ownership than for renting: you can make a lot or lose a lot. On average, buying is the better decision for the price range of houses I'm looking at, but the potential downside is a bit daunting. Reinforces my inclination to buy something cheap.

I don't have any particular questions here - just wondering if y'all have any input, or think that I'm going about this the wrong way. Would be happy to talk about the model a bit more.
Making a lot shouldn't be the goal of housing. Choose housing that is right for the lifestyle you and your family need/want, without becoming house poor. If you are considering your home purchase decision as an investment, you are "going about this the wrong way".

Similarly, don't choose a house, car, or wife based on your expected return.
I'll leave the "something cheap" discussion of those items to others.

rbaldini
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Re: The riskiness of home ownership

Post by rbaldini » Tue Oct 18, 2016 6:45 pm

KlangFool wrote: 1) I bought a house with my rules.
KlangFool
Great. Most people can't. And perhaps they shouldn't - that's the issue I'm bringing up. Perhaps there *should* a rule that says "don't buy any house that's more than x% of your net worth". I'd personally think your suggestion is too conservative, but again to each his own.
KlangFool wrote: << But rent money goes into a black hole, whereas any money paid in PITI partly goes to paying off a loan. Assuming common house price increase, >>

This is how people buy TOO MUCH HOUSE and got themselves KILLED by THE HOUSE. The house price around here is not back to the 2004/2005 level. And, this is one of the hottest areas.
Sure. In general I agree with you - the point of this thread, after all, is to draw attention to the risks of house purchase. I'm just inclined to be not quite as conservative as you. It's true that *usually* one can afford more in PITI in the long term than in rent, but the downside is large, as I've emphasized. Obviously it's a risk - one that needs to be understood by the buyer.

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Re: The riskiness of home ownership

Post by rbaldini » Tue Oct 18, 2016 6:47 pm

joebh wrote: If you are considering your home purchase decision as an investment, you are "going about this the wrong way".
I wouldn't say I'm approaching it as investment. I'm simply looking at what the range of possible financial outcomes are for each option (rent vs buy), and comparing them. Usually the house wins (for the range I'm looking at), but sometimes it loses badly. Higher risk, higher return. That's all.

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Watty
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Re: The riskiness of home ownership

Post by Watty » Tue Oct 18, 2016 6:49 pm

The stage of life you are in also matters a lot. I retired last year and having a paid off house really makes my numbers work better since I do not need to worry about rent increases or having my investments under perform and make it hard to pay the rent. By not having a rent or mortgage payment there is less sequence of returns risk. The example that I have given before when people ask the "Should I pay off the mortgage?" question.
 If you do not pay it off then you will have more sequence of returns risk. For example in rough numbers if you just kept a $100K mortgage and also put $100K into a separate investing account which you also paid a $500 a month mortgage out of then;

a) If you get unlucky and get a modest 10% decline in the portfolio the first year then it would be down to $90K
b) You would also need to pay the $500 a month mortgage($6,000) so your portfolio would be down to $84K
c) To break even the next year you would need to gain back the $16K and another $6,000 for the next years mortgage payments which is $22K. That would take a 25.6% return on the remaining $84K just to break even.

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Re: The riskiness of home ownership

Post by dumbbunny » Tue Oct 18, 2016 7:27 pm

Watty wrote:The stage of life you are in also matters a lot.
Too many of my friends are facing illnesses or have taken their last breath. I am 62 years old and just spent 1/3 of my net worth on house on a golf course. Was it risky - maybe. Will I make money - maybe. Will I die someday - Yes. Time to hit a bucket of balls.
“It’s the curse of old men to realize that in the end we control nothing." "Homeland" episode, "Gerontion"

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Re: The riskiness of home ownership

Post by KlangFool » Tue Oct 18, 2016 8:15 pm

rbaldini wrote:
joebh wrote: If you are considering your home purchase decision as an investment, you are "going about this the wrong way".
I wouldn't say I'm approaching it as investment. I'm simply looking at what the range of possible financial outcomes are for each option (rent vs buy), and comparing them. Usually the house wins (for the range I'm looking at), but sometimes it loses badly. Higher risk, higher return. That's all.
rbaldini,

I disagreed. Let's take another point into consideration. For my peers in 25% marginal tax rate, when they bought TOO MUCH HOUSE, they cannot contribute to Trad. 401K. So, essentially, they are paying 25% TAX plus 5+% state income tax for each additional dollar spent on housing. So, how could they win? This is 30+% extra tax for additional housing expense.

For the price range of the house that you are looking at, could you still contribute to the MAX of all your tax advantaged accounts? If the answer is NO, you have to take additional tax into consideration.

In my case, with my CONSERVATIVE RULES, I could contribute to the max for all my pre-tax accounts even with a mortgage.

KlangFool

rbaldini
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Re: The riskiness of home ownership

Post by rbaldini » Tue Oct 18, 2016 8:24 pm

KlangFool wrote: For the price range of the house that you are looking at, could you still contribute to the MAX of all your tax advantaged accounts? If the answer is NO, you have to take additional tax into consideration.
KlangFool
Yes - I would not buy a house if it meant forfeiting tax-advantaged contributions. My model assume no tradeoff there. Mind you, if the house price increases, you get a potentially big capital gain with 0 tax (assuming you get <500k). That is one big reason buying a house can work out. But, as I said from the beginning, it also goes the other way. High risk, high reward.
Last edited by rbaldini on Tue Oct 18, 2016 8:25 pm, edited 1 time in total.

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SeeMoe
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Re: The riskiness of home ownership

Post by SeeMoe » Tue Oct 18, 2016 8:25 pm

The reason we owned 3 houses over the years was the privacy and certainty that ownership provides. The best one was in North Philadelphia in the 1970's . It was just a stone and brick rowhouse with hardwood floors and a

baseboard hot water heating system,..the best, and cheap to maintain . Cost us $25k and sold it for $45k 19 years later. Should have gotten more, but " blockbusters " were doing their duty in the hoods then. Still, it was a nice place, and ours.

SeeMoe.. :wink:
"By gnawing through a dike, even a Rat can destroy a nation ." {Edmund Burke}

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Re: The riskiness of home ownership

Post by KlangFool » Tue Oct 18, 2016 8:34 pm

rbaldini wrote:
KlangFool wrote: For the price range of the house that you are looking at, could you still contribute to the MAX of all your tax advantaged accounts? If the answer is NO, you have to take additional tax into consideration.
KlangFool
Yes - I would not buy a house if it meant forfeiting tax-advantaged contributions. My model assume no tradeoff there. Mind you, if the house price increases, you get a potentially big capital gain with 0 tax (assuming you get <500k). That is one big reason buying a house can work out. But, as I said from the beginning, it also goes the other way. High risk, high reward.
rbaldini,

In my area, annual median household income = 150K. Median house price = 600K. My peers chose to buy the median house and they were "House Poor".

KlangFool

rbaldini
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Re: The riskiness of home ownership

Post by rbaldini » Tue Oct 18, 2016 8:41 pm

KlangFool wrote:
In my area, annual median household income = 150K. Median house price = 600K. My peers chose to buy the median house and they were "House Poor".

KlangFool
Sounds like a tough place to be. I can see why your rules would be a good idea there.

...especially given the amount of bad advice that's out there. According to Zillow (https://www.zillow.com/mortgage-calcula ... rdability/), with a combined salary of ~$200k from my wife and me, we should be able to "comfortably" afford a million dollar house. That seems downright unethical, even if their job is to sell houses.

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Re: The riskiness of home ownership

Post by KlangFool » Tue Oct 18, 2016 8:51 pm

rbaldini wrote:
KlangFool wrote:
In my area, annual median household income = 150K. Median house price = 600K. My peers chose to buy the median house and they were "House Poor".

KlangFool
Sounds like a tough place to be. I can see why your rules would be a good idea there.

...especially given the amount of bad advice that's out there. According to Zillow (https://www.zillow.com/mortgage-calcula ... rdability/), with a combined salary of ~$200k from my wife and me, we should be able to "comfortably" afford a million dollar house. That seems downright unethical, even if their job is to sell houses.
rbaldini,

Many of my peers make that much in their household and their house is around 600K or more. It is abnormal around here to spend much less.

KlangFool

Caduceus
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Re: The riskiness of home ownership

Post by Caduceus » Tue Oct 18, 2016 9:03 pm

There are two separate questions. You will almost always come out ahead by buying the cheapest place that you are happy with, because you are consuming the least imputed rent. This is one of the best arguments against thinking about homes as investments, because in most cases, the majority of real estate's returns comes from its rents, and living in a house means you consume 100% of its rents (unlike a real estate business owner who rents the place out).

But if you intend to stay in a place for a long time, and assuming the house is fairly valued using metrics like price-to-rent ratios and prices against comparable properties, etc., buying to own rather than renting is generally better. You can take a variety of tax deductions, you have potential tax protection on the upside for capital gains, and most people cannot leverage their assets at such a low rate except with a mortgage.

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Re: The riskiness of home ownership

Post by AlohaJoe » Tue Oct 18, 2016 9:28 pm

rbaldini wrote:To investigate this, I made a stochastic simulation of the costs of renting vs. buying. I modeled it off of the NYTimes website (http://www.nytimes.com/interactive/2014 ... lator.html), except that rather than having the user input the market and house returns, I simulated 1000's of possible future time series based on some historical data for both stock returns and Boulder house prices.
This is an interesting approach, I like it.

I'm surprised that housing prices are normally distributed; did you test for normality?

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Re: The riskiness of home ownership

Post by vitaflo » Tue Oct 18, 2016 9:32 pm

happyisland wrote:
mouses wrote:I've never bought a house as an investment, rather as a home.
Agreed. From my understanding, it is generally a bad idea to expect a house to appreciate like an actual investment.
Houses are a good inflation hedge. Of course over the last 30 years that hasn't meant a whole lot.

Dottie57
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Re: The riskiness of home ownership

Post by Dottie57 » Tue Oct 18, 2016 9:42 pm

rbaldini wrote:
Dottie57 wrote:
rbaldini wrote:
mhc wrote:You also have the risk that comes from having a concentrated position. A lot of homeowners have a large percentage of their wealth tied up in their houses. Not very diversified.
Right. It's strange to me that this is rarely discussed. There's a common rule of thumb for mortgage-to-income ratio, which goes something like "don't take on a mortgage bigger than 3x your income", etc. But I've never seen any rule of thumb regarding house-value-to-net-worth ratio - e.g., don't have your home be more than 50% of your net worth, or something. Possibly because such a rule would strongly discourage home ownership except among those with large net worth.
Networth is assets -liabilities. When I bought my house my networth was definitely negative
Right. Hence the difficulty of any net-worth-based rule of thumb. Most people wouldn't be able to afford houses if they followed a rule that said something like "don't buy any house greater than one's net worth." Still, it's strange that we think it's "okay" for someone to buy a house whose value dwarfs the buyer's net worth...[/quote

Many people buy more than they should... HGTV is to blame.

rbaldini
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Re: The riskiness of home ownership

Post by rbaldini » Tue Oct 18, 2016 9:46 pm

AlohaJoe wrote: I'm surprised that housing prices are normally distributed; did you test for normality?
The model assumed that the annual log changes in house price are normally distributed, not house prices themselves (which I'm sure are not! they're heavily skewed). I actually didn't even check whether this was reasonable, though I suspect it's a close enough approximation. Will double check when I get back on my work computer.

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Re: The riskiness of home ownership

Post by Valuethinker » Wed Oct 19, 2016 3:06 am

KlangFool wrote:OP,

I have 2 rules that EVERYONE does not like.

1) The house's price has to be 1/2 to 1/3 of your net worth excluding the house.
I would that I could afford that rule in London! ;-). I'd be planning my retirement as we speak.

If you live in a HCOL area, no dice.
2) The mortgage payment (PITI) has to be CHEAPER than renting. No game is allowed. You have to compare the HOUSE that you are buying versus RENTING. Most people play a game by comparing the HOUSE that they buy and ASSUME that they will RENT the same HOUSE. That is NOT TRUE. Most people RENT less house.

Now, if you follow those 2 rules, you DO NOT CARE whether you make money from THE HOUSE. You will buy LESS HOUSE. It is THE SAME or CHEAPER than RENTING. You count THE HOUSE as an ongoing expense.

KlangFool
Again re 2 not possible in London. But generally it's the size of downpayment (£100k+) that is the issue rather than the monthly payment.

Note if you move further out you pay more to commute (season's rail ticket can be £3500+ pa) so it's hard to gain just by moving out.

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Re: The riskiness of home ownership

Post by Valuethinker » Wed Oct 19, 2016 3:10 am

rbaldini wrote:Y'all,

I'll likely be buying a house some time in the next year, in the Boulder, CO area. I've been thinking more about the financial aspects of home ownership. It recently struck me that buying a house on a loan is relatively risky decision, in the sense that the range of outcomes is greater than renting + investing that money in the market - i.e. you can make a lot, but you can also lose a lot. I think there are two main reasons for this:
(1) Since you can buy a house with only 20% down, you can leverage to potentially realize very large returns or losses. For example, with only $100,000 you can buy a $500,000 house, and therefore realize the returns or losses of whatever happens to that house (minus interest on loan, commission to realtor, etc.).
(2) The lack of a capital gains tax on your residential property (well, on the first $500k for a married couple) swings both ways: you don't pay taxes if you win, but you can't write it off if you lose... right?

To investigate this, I made a stochastic simulation of the costs of renting vs. buying. I modeled it off of the NYTimes website (http://www.nytimes.com/interactive/2014 ... lator.html), except that rather than having the user input the market and house returns, I simulated 1000's of possible future time series based on some historical data for both stock returns and Boulder house prices. Long story short, it is indeed the case that the range of costs is usually greater for home ownership than for renting: you can make a lot or lose a lot. On average, buying is the better decision for the price range of houses I'm looking at, but the potential downside is a bit daunting. Reinforces my inclination to buy something cheap.

I don't have any particular questions here - just wondering if y'all have any input, or think that I'm going about this the wrong way. Would be happy to talk about the model a bit more.
All very interesting but the past is not like the future.

As a rule of thumb, the data in Shiller is probably useful, ditto Neil Monnery "Safe as Houses" (a compedium of international housing price data, last 800 years).

The long run trend growth in Boulder CO RE is probably useful as a baseline forecast. What would change it is 1). loss of local industry (think Detroit) and terminal decline or 2). increased tightening of zoning, making it harder to build new homes (a common feature in high housing cost areas) 3). secular trend for people to move to CO (happening, I gather, due to what's happening in California, Portland OR etc.?).

You have to think of a home as a lifestyle/ consumption choice, and a mehhh investment that has certain tax advantages.

Then you build up home equity by paying down the mortgage. It's a cheap source of finance to finance your contributions to tax deferred or exempt accounts and to refinance other debt, and other than that, you pay it down (at a higher IRR than investing in US government bonds, currently). It is also a liquidity hedge (the money is long term) and an inflation hedge (long term fixed rate mortgages are an inflation hedge).

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Re: The riskiness of home ownership

Post by topofthebellcurve » Wed Oct 19, 2016 4:53 am

KlangFool wrote: In my area, annual median household income = 150K. Median house price = 600K. My peers chose to buy the median house and they were "House Poor".
KlangFool
Sounds like Boston! About to move there from Shanghai...am not excited about the upcoming ~3X cost of living increase. Only upside is that my wife will go from $40K to $140K....

I have a deep love of optionality given the extraordinary, inherent unpredictability of the future X years out (may come from working in real estate and seeing how far off "underwriting" is from "actuals"). I've never owned a home and am likely to rent for as long as possible (perhaps forever!). Similarly, I'll probably just lease cars -- would rather "burn" $5,000/yr in lease payments and know I can optimize to my needs every 3 years. Isn't the average cost of car ownership like $8k/yr anyway?

Flexibility is undervalued, in my opinion. I can understand the emotional value of owning a house, but I also take comfort in knowing that my housing cost is fixed and predictable at $X/month, and I'm not at risk of a huge roof repair or other unforeseen expenditure.

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Re: The riskiness of home ownership

Post by bberris » Wed Oct 19, 2016 5:59 am

mouses wrote:I've never bought a house as an investment, rather as a home.
The housing market doesn't care about your intentions. You still are choosing between renting and buying, and there are consequences.

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Re: The riskiness of home ownership

Post by joebh » Wed Oct 19, 2016 7:00 am

topofthebellcurve wrote:Similarly, I'll probably just lease cars -- would rather "burn" $5,000/yr in lease payments and know I can optimize to my needs every 3 years. Isn't the average cost of car ownership like $8k/yr anyway?
Do your car needs change that rapidly?

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Re: The riskiness of home ownership

Post by nisiprius » Wed Oct 19, 2016 7:14 am

Home ownership certainly felt risky to us. It was one of these things--like getting married and having kids--where we shrugged and said, "Well, other people are doing it and if they can swing it, we can probably swing it."

When we bought our house, inflation was galloping, so were mortgage rates, and housing prices in our area were rising much faster than inflation. It definitely felt like a "now-or-never" situation. The cost of the house we bought was 2.45 times our income--which in those days was considered extremely high, and our first mortgage application was denied because of it, I'm astonished at what people think is OK nowadays. We put every penny of savings into the down payment, and had to borrow some money from my father-in-law, so our net worth was negative. And the interest rate was 9% on a thirty-year mortgage, which meant that, if I recall correctly, at the very beginning each monthly payment was paying down less than $10 of the principal. For a long time any extra money we got, we chucked at the principal, because it didn't take very many dollars to shorten the the mortgage term by a lot.

9% was quite horrifying at the time. These were the days when many states, including the one I lived in, still had usury laws. The interest rate on credit cards was capped at 12% and I said to my wife "9%? 9%? Heck, it wouldn't cost that much to just put the house on our credit card."

Truth-in-lending was still very new, and at the closing everybody including our own lawyer encouraged us not to really look at the truth-in-lending statement, because they all wanted the deal to go through and they were terrified that we would back out when we found that our total mortgage payments over the life of the loan would add up to over three times the price of the house.

Best single piece of financial advice I ever got was from my father-in-law, who strongly encouraged us to get the 9% fixed-rate mortgage instead of the 8.75% adjustable--despite all the urging from the bank about how terrific these innovative new adjustable-rate mortgages were, and how all the cool people were getting them, and how much the lower rate on the adjustable could save us. To be sure, I was put off when the bank refused to give us a written explanation of how the adjustable rate was calculated. They said the details were in the mortgage agreement, I said "great, send me a copy of the mortgage agreement," and it was oh, no, we couldn't do a thing like that...
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Re: The riskiness of home ownership

Post by jpelder » Wed Oct 19, 2016 7:29 am

topofthebellcurve wrote:
KlangFool wrote:

Isn't the average cost of car ownership like $8k/yr anyway?
My math says about $4000 per year if I keep my current car for 10 years, but I own a small car. That said, I have nice insurance (State Farm with full coverage) and live in a state that charges property tax annually on cars (mine is around $250 per year). My annual costs will be lower if I keep my car for 11 or 12 years, which is relatively likely (6 years old now and no repairs besides warranty work and routine maintenance)

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Re: The riskiness of home ownership

Post by topofthebellcurve » Wed Oct 19, 2016 7:52 am

joebh wrote:
topofthebellcurve wrote:Similarly, I'll probably just lease cars -- would rather "burn" $5,000/yr in lease payments and know I can optimize to my needs every 3 years. Isn't the average cost of car ownership like $8k/yr anyway?
Do your car needs change that rapidly?
Haha, well I haven't owned a car in ~8 years, and I may be starting a family soon....so quite likely yes. At least over the next 5-10 years.

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Re: The riskiness of home ownership

Post by wolf359 » Wed Oct 19, 2016 7:59 am

rbaldini wrote:
mhc wrote:You also have the risk that comes from having a concentrated position. A lot of homeowners have a large percentage of their wealth tied up in their houses. Not very diversified.
Right. It's strange to me that this is rarely discussed. There's a common rule of thumb for mortgage-to-income ratio, which goes something like "don't take on a mortgage bigger than 3x your income", etc. But I've never seen any rule of thumb regarding house-value-to-net-worth ratio - e.g., don't have your home be more than 50% of your net worth, or something. Possibly because such a rule would strongly discourage home ownership except among those with large net worth.
In "The Millionaire Next Door," Dr. Stanley found that at death, the value of the homes for multi-millionaires averaged 10% of their net worth. He found that most of the wealthy who live in big homes in high-status neighborhoods bought them AFTER they were already wealthy. If you're trying to build high net worth, you should keep your expenses low. He recommended that your mortgage not be bigger than 2X your income. He also recommended that the market value of the home be less than 3X your income.

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Re: The riskiness of home ownership

Post by White Coat Investor » Wed Oct 19, 2016 8:20 am

mouses wrote:I've never bought a house as an investment, rather as a home.
Yes, it has both consumption item aspects and investment aspects.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

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Re: The riskiness of home ownership

Post by Johnnie » Wed Oct 19, 2016 8:22 am

What White Coat said (at the moment I was writing this!)

My watchword has long been: Homes are consumption not an investment, so less is more.

I learned that from my mom back in the early 1970s when she was flipping houses in a hot California market, including the homes she lived in. She said, "The one you live in isn't an investment because when you sell it you need another right away." She was just having creative fun with those ones.
"I know nothing."

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Re: The riskiness of home ownership

Post by dbr » Wed Oct 19, 2016 8:30 am

White Coat Investor wrote:
mouses wrote:I've never bought a house as an investment, rather as a home.
Yes, it has both consumption item aspects and investment aspects.
I've never understood not recognizing a home as an asset that can change in value, imposes costs, provides a value (place to live) and can be exchanged for money -- ie is an investment for all practical purposes.

At the same time I have never understood not recognizing the unique character of a home as a lifestyle item that creates motivations in owning or not owning a home that are not financial motivations.

I don't know what a home being a consumption item means.

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Re: The riskiness of home ownership

Post by mouses » Wed Oct 19, 2016 8:48 am

bberris wrote:
mouses wrote:I've never bought a house as an investment, rather as a home.
The housing market doesn't care about your intentions. You still are choosing between renting and buying, and there are consequences.
Not if I keep my home for my lifetime. All this stuff about prices becomes a non-event. And I avoid losing my "home" and having to move because the landlord raises the rent astronomically or decides to sell the house. I don't have to put up with him or his people disturbing my privacy. I get to choose my house color and plantings, etc.

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Re: The riskiness of home ownership

Post by Johnnie » Wed Oct 19, 2016 8:55 am

Johnnie wrote:What Mouses said.

My watchword has long been: Homes are consumption not an investment, so less is more.

I learned that from my mom back in the early 1970s when she was flipping houses in a hot California market, including the homes she lived in. She said, "The one you live in isn't an investment because when you sell it you need another right away." She was just having creative fun with those ones.
"I know nothing."

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Re: The riskiness of home ownership

Post by rarara » Wed Oct 19, 2016 8:55 am

rbaldini wrote:
mhc wrote:You also have the risk that comes from having a concentrated position. A lot of homeowners have a large percentage of their wealth tied up in their houses. Not very diversified.
Right. It's strange to me that this is rarely discussed. There's a common rule of thumb for mortgage-to-income ratio, which goes something like "don't take on a mortgage bigger than 3x your income", etc. But I've never seen any rule of thumb regarding house-value-to-net-worth ratio - e.g., don't have your home be more than 50% of your net worth, or something. Possibly because such a rule would strongly discourage home ownership except among those with large net worth.
Agree with this. Very good point

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Re: The riskiness of home ownership

Post by mouses » Wed Oct 19, 2016 8:55 am

topofthebellcurve wrote:I'll probably just lease cars -- would rather "burn" $5,000/yr in lease payments and know I can optimize to my needs every 3 years. Isn't the average cost of car ownership like $8k/yr anyway?
I have two cars, the only two cars I've ever bought in my decades of life. Their cost divided by the years I've owned them is probably like $50 (one is almost 50 years old, the other, about 25 years old, was bought used.) I maybe spend a total of a few hundred dollars a year on repairs. Insurance total is $1,300. I assume you're not counting gas since you pay for that in both cases.

So my annual cost per car is maybe $800.
Last edited by mouses on Wed Oct 19, 2016 8:58 am, edited 1 time in total.

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Re: The riskiness of home ownership

Post by dbr » Wed Oct 19, 2016 8:57 am

mouses wrote:
bberris wrote:
mouses wrote:I've never bought a house as an investment, rather as a home.
The housing market doesn't care about your intentions. You still are choosing between renting and buying, and there are consequences.
Not if I keep my home for my lifetime. All this stuff about prices becomes a non-event. And I avoid losing my "home" and having to move because the landlord raises the rent astronomically or decides to sell the house. I don't have to put up with him or his people disturbing my privacy. I get to choose my house color and plantings, etc.
The value of your home when you die is of interest to your heirs the same as the value of everything else you own when you die. If your object is to have consumed all your assets by death, you certainly would want to extract the asset value of your home along the way.

It is a great outcome to be able to live out one's life in one's own home, but that is not always possible and the asset value of the home may be significant in what happens when one needs or wants to move elsewhere.

The positive aspects you mention are lifestyle aspects that are the primary drivers for most people in choosing whether to rent or buy. That does not mean a home is financially non-existent.

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